The country might also reduce the number of borrowings from international lenders by providing to the borrowers alternate source of funding



By Muhammad Bashir Chaudhry
Oct 13 - 19, 2003



Pakistan's stock of external debt that was nearly $22 billion in 1990 reached almost $38 billion by June 1999. In order to cover deficiencies in the external sector, the previous governments resorted to heavy borrowings from a variety of sources. Due to seriousness of the situation, borrowings were in many cases made regardless of cost from diverse sources including commercial banks. As a result, in a few years the debt servicing burden became almost unbearable. The present government, realizing the grave situation, took a number of remedial measures. Following the Debt Reduction and Management Strategy, the country has succeeded in arresting the rising trend in its external debt and foreign exchange liabilities. Total external debt liabilities, including foreign currency accounts, have reduced to $36.5 billion in June 2002 and further to $35.5 billion in June 2003. Even this level of external debt and liabilities is high and might have potential problems for the country. It would be a challenge to reduce foreign debt and liabilities in the coming years or even to maintain these at present volume while continuing execution of development projects. There might be a fighting chance for that provided rigorous debt management regime is firmly put in place with full commitment of the stakeholders to this effect.

The creditors to Pakistan comprised mainly the developed countries, the International Financial Institutions (IFIs), the commercial banks and private investors. The developed countries and the IFIs have been playing important role in the overall economic and social development of Pakistan. Bilateral loans from the developed countries helped the country increase pace of economic development including setting up of a number of industries and thereby providing employment and value addition. However, due to institutional weaknesses, the country could not fully benefit from the foreign assistance. It is alleged that use of funds was in some cases tardy and wastage was high particularly due to faulty design of the projects and their poor execution. Despite some changes in priorities due to geo-political situation, these countries even today are offering financial and technical help particularly in social sectors. We have to overcome our weaknesses and develop capability to better interact with these countries and be able to obtain economic assistance in larger amounts and at better terms. We also have to demonstrate that we are now better equipped to execute the projects successfully and to realize the envisaged benefits fully.

The IFIs have also contributed for the economic/social progress and as of June 2003, Pakistan was indebted to nearly $ 15 billion. On the basis of ongoing projects as well as the projects in the pipeline, indebtedness to these institutions is likely to increase in the coming years. These IFIs, though public sector institutions, have been showing good profits as their overall lending has been good. Like all conservative lenders, these IFIs are always on the look out for credible borrowers. At present these IFIs are showing keen interest for lending to Pakistan that has been able to attain better credibility through a number of measures by the present government, with assistance from these IFIs, and due to certain external favourable factors. The government has committed to the IFIs to continue with the reforms. The IFIs are said to be with the government as long as reforms in the financial and other sectors are on track. Our aim should be to reduce the foreign debt and liabilities to within safe limits while maintaining economic growth in the country. For that, it is imperative that past mistakes are avoided; foreign funds are borrowed more efficiently for priority projects that are executed diligently with minimal wastage and that the project objectives are fully realized for enhancing welfare of the people.



During the last about four years, there has been broad-based improvement in macro-economic indicators. However, the level of savings and investment has not witnessed same buoyancy due to different reasons. Now that macro-economic conditions have improved, the government has initiated efforts for generating employment and for poverty alleviation. The government is expected to also take further measures for curtailing current expenditure. Larger outlays by the government would act as a catalyst for encouraging private sector for more investments in productive sectors.

The government has already taken measures to contain the foreign debt/liabilities and to improve management thereof. Major portion of the commercial banks' debt and the bonds have already been retired. The government has succeeded in getting the Paris Club debt re-profiled. The Debt Office of the Ministry of Finance has also identified the expensive debt and is examining the terms and conditions associated with pre-mature payments. The government reportedly has plans to retire one billion dollars during the current year. The Finance Minister reportedly has declined the offer of a new package from the IMF due to the conditionalities. These measures by the government have given some relief to the general public that things are on the mend. However, in order to build on the progress so far made in debt management, it is essential that a better approach to future borrowings is put firmly in place by the economic managers of the country.

These days the IFIs particularly the World Bank and the ADB appear keen to enlarge their lending operations in the country. The World Bank is likely to provide $5 billion over the next five years for capacity building, structural reforms and infrastructure programmes. The ADB also has its credit plans for Pakistan for the next few years though the loans' volume might not match that of the World Bank. A new trend in borrowing is taking shape. Now the provincial governments might be borrowing directly from these multilateral institutions instead of borrowing through the federal government as in the past. These developments call for a second look at our current borrowing practices, preferences and strategies. Also, the capacity of our people handling debt negotiation, administration and project execution must be enhanced through appropriate training measures.

In the context of future borrowings for economic and social development projects, major focus has to be on important areas such as the justification of the project, capital cost, rationale for mobilizing debt, preferred sources of funds, overall cost of debt, flexibility in utilization, institutional arrangements for project execution and the conditionalities being imposed by the lenders for making structural changes. Some of these areas are discussed in more detail below. It might be appreciated that the borrowing strategy adopted by the government and the public sector enterprises also serves as a guide to the private sector borrowings.

The SBP and SECP have been obliged to set up a joint task force to tackle the untoward situation developed due to alleged cheating of many Pakistani depositors by the exchange houses/financial advisory companies/brokerage firms, which were illegally taking foreign currency deposits for investment abroad. The amounts involved are said to be very large. Earlier similar incidences involving loss of large amounts had happened in Karachi and elsewhere when rupee deposits were illegally taken by the investment companies by duping the depositors. The perpetrators of such scams generally offer higher rates of profit on deposits as compared to the profit offered by the commercial banks. Such dubious schemes quickly prosper and the depositors are duped due partly to lack of opportunities for making safe investments with reputable institutions other than the commercial banks. The government is urged to examine the situation and set up Special Funds for attracting such deposits in rupees as well as in foreign currency. These Special Funds would eventually become an alternate source of funds for execution of public as well as private sector projects. The profit to be paid on borrowings from such Special Funds should be comparable on after-tax basis with the interest that would have been paid if the borrowings were made from the foreign lenders. Interest on loans from the IFIs and the developed countries are almost always tax exempt. These Special Funds, with large deposits/investments, would also save the depositors from the likes of unscrupulous 'brokers/investment advisors' mentioned above.

The country might also reduce the number of borrowings from international lenders by providing to the borrowers alternate source of funding out of the country's foreign exchange reserves. At present our foreign reserves are at a reasonable level of $ 11 billion, a small part of which might be given to the existing banks/DFIs as credit lines to be used to finance import of plant and equipment by both public and private sector enterprises. If managed prudently, such a scheme would boost industrial activity, enhance competitiveness, generate employment and alleviate poverty.

Justification of a project provided on the basis of its potential benefits coupled with the offer to meet the foreign cost, normally sets the stage for international borrowings by the developing countries. It is not uncommon that the project ideas were promoted by the IFIs in the context of overall economic and social development priorities of the country or in tandem with existing projects already under execution. The support of the multilateral institutions might be welcome but the local authorities must first satisfy themselves with the need, scope and justification of such a project. To entice the local authorities, sometimes the project promoters overstate the potential benefits while the costs are initially understated. Some of the stakeholders and the potential beneficiaries in one way or the other, in due course become interested in the project, which then gains its own momentum. Sometimes, the project promoters present the project proposal to the government authorities and also through information media advertise the benefits that would accrue to the people once the project is executed. They are not likely to reveal the down side of the project, and whenever, they have to do so they grossly understate the same. The practice of such promoters is not going to change easily. However, the country has to learn to be more selective in taking up consideration of the projects so proposed.



The lenders generally add and modify loan conditions at all stages of the project up to the final negotiations and execution of loan documents. The wordings of the special conditions may appear innocent but might show commitment by the government for taking certain important measures. All these terms and conditions might be understood properly and agreed only after clear decision to this effect by the government. Some of the matters may be inserted in the documents subject to the concurrence of the same by the higher authorities at a later stage. Pre-appraisal and appraisal stages of the projects are important and only those points or conditions should be inserted in the draft agreement that have been earlier discussed and agreed. The wording of the conditions is critical and might not be allowed if it is different from what has been earlier agreed by the higher authorities.

The developing countries often are obliged to raise foreign debt for execution of certain priority projects. As part of the transaction, the lenders sometime provide with the services of experts. The borrowers have the habit of underrating the capabilities of their own experts and readily agree to the findings of the foreign experts. The time has already come for due recognition of the capabilities of our local experts. Justification for the scope of the project, the loan amount and foreign experts need to be critically evaluated by the local teams and in the light of the findings adjustments have to be made where considered appropriate.

In the past, the country has borrowed foreign currency to meet rupee cost of a project or activity in the public sector enterprises. The country was thus able to improve its reserve position. Having exchange reserves at about $11 billion, the country might consider changing this practice. Financing of rupee cost through local resources should be made one of the cardinal principles of debt management. Some of the reforms programmes being negotiated with World Bank and ADB can be easily undertaken locally using rupee finance. Reforms pertaining to areas such as judicial, police, education or financial sector can be easily executed by mobilizing rupee resources from the domestic market. Moreover, foreign borrowing to meet the foreign cost should not be the first option. Other options available domestically to meet such cost must first be carefully explored.

Friendly countries sometimes offer commodities on deferred payment basis. At times, such countries also place large foreign currency deposits with a developing country. These measures improve the foreign reserves position of the recipient country. However, in due time the liability has to be paid with interest. In such transactions, the borrower might not be in a position to objectively negotiate the price or other terms of the facility. Such gestures help cement better relations with other countries and should be continued as long as these are mutually beneficial.

Sources of debt must be selected carefully. The IFIs and the official agencies of the developed countries are the safest bet. Reputed commercial banks are the last choice. It is considered advisable not to contact or correspond with individuals or unknown investment firms purportedly acting as advisors for raising debt.

The IFIs have different financing facilities and the developing countries must opt, if they have a choice, to a loan with the lowest interest. Some facilities are without interest but small service charges are payable. For regular loans overall cost has to be less than the market for same tenure, currency and flexibility in the use of funds. More care has also to be given to the conditionalities particularly the ones requiring structural changes or the passing of new laws or both. The negotiating team before proceeding abroad must seek clear instructions from the government on such matters. The composition of the team has to be proper and officers from the executing/implementing agencies must be associated at all stages of project appraisal and loan negotiation. All members of the team must have full command over their respective areas of responsibilities and should be trained well for debt negotiations. Hard work, diligence and commitment make the difference in such matters.